Market Commentary

Fed flip-flops disrupt global financial markets in Q4 creating value

January 2019

Now that the dust has settled, 2018 will be commonly looked at as “the year that nobody made money.” Of 94 Morningstar Mutual Fund categories, 86% were negative for the year. And of the 13 that were positive, 7 of them were municipal bond funds (excluding single state municipal bond funds). 2015 was characterized by CNBC as the most difficult year to make money in 78 years. When the final month of year, December, was the worst since 1931, it’s safe to say 2018 was even more challenging than 2015.

Volatility was a mirror image of extremes from 2017. Investors endured two 10%+ corrections in 2018, key stock market indexes (Nasdaq, Russell 2000, S&P 400) hit bear market territory (-20%) in December, while at the same time seeing the markets twice set new all-time highs, along with a record setting bull market run in Q3, as well as the Dow posting its all-time single-day point gain in December.

The Federal Reserve was the eye of the storm throughout the year. In late January after stocks set a new all-time high, a hot wage number sparked fear that the Fed would be raising interest rates more than expected and stocks plunged 10% as interest rates spiked. Ever since the financial crisis, the Fed has been adamant about transparency and guidance. While transparency remains high, the Fed’s guidance and comments have been erratic this year sending mixed messages to the market. Fed Chair Powell’s comments October 3rd that the Fed was “a long way from neutral” caught the market by surprise and sparked the Q4 market sell-off and interest rates spiked to their highest levels of the year. It wasn’t until just after Thanksgiving that Powell walked back his remarks that the Fed was actually “just below neutral” with policy rates. That ignited a major rally that lifted stocks to gains for November. The Fed raised rates, as expected, for the fourth time at its December meeting but instead of a soft “dovish” statement, Powell said the Fed was on “auto-pilot” with its balance sheet plan. That sent stocks reeling right through Christmas Eve staring a bear market right in the face. Yet again, on December 26th Powell walked back his comments and reinforced that the Fed was on “no set path” to raising interest rates and it “will be patient” given how the economy performs and would “adjust policy quickly and flexibly.” Not only did Powell's comments calm the markets, they cleared the runway for Santa to indeed pay a visit to Wall Street, igniting a massive rally in stocks as investors sought to scoop up great values. The Dow surged 1086 points, or 4.98%, for it’s best single-day point gain ever! It would be the start of a strong year-end rally that would end an otherwise terrible 2018 on a positive note.

Also contributing significantly to the volatility throughout the year was the ongoing trade war with China and growing concerns about slowing global economic growth and de-synchronization. Despite the corrections and bear markets from their highs, stocks finished the year with more manageable losses. Large-caps outperformed their small- and mid-cap peers handily, as the Dow, S&P 500 and Nasdaq posted single-digit losses for the year at -5.6%, -6.2% and -3.9%, respectively. The Russell 2000 and S&P 400 sank 12.2% and 12.5%.

Foreign Markets, both developed and emerging underperformed all year and each hit bear market territory from their 2018 highs in December. The MSCI EAFE index fell 16.1% for the year, while the MSCI Emerging Market index fell 16.6%.

Thanks to a rally on the last day of the year, the bond benchmark Barclays Bloomberg Aggregate Bond index finished with a 0.1% total return gain for 2018. However, many bond categories finished with losses for the year given the interest rate challenges. The 10-year Treasury Note yield finished at 2.68%, up 27 basis points for the year but well off the high of 3.25% hit in early October.

Special January 2019 Update

Fed Chair Powell’s “dovish” comments on December 26th not only sparked the year-end Santa Claus Rally, it has powerfully continued into the New Year. Positive developments on a US-China trade deal have emerged, as well as new economic stimulus for the slowing Chinese economy.

From the Christmas Eve lows, the major stock indexes have surged double digits ending January 18th. Small-caps have led the charge gaining 17%, while mid-caps and Nasdaq not far behind gaining 15.9% and 15.6%, respectively. The Dow and S&P 500 have surged as well, posting gains of 13.4% and 13.6%. 2019 Year-to-date gains are off to a strong start with mid to high single-digit gains across the board. Foreign stocks have gained as well from the lows but have lagged with single-digit returns. As market risk appetite has returned, volatility has declined from elevated levels and interest rates have edged higher, with the 10-year T-Note yield rising to 2.78%; however, it has also renewed interest in corporate investment grade and high yield bonds, with both outperforming Treasuries.

The following is our 2019 Outlook, including Catalysts and Concerns, and we look forward to the opportunities and challenges ahead as they present themselves.

2019 Outlook

While there is still a lot of work to be done to repair the damage from the 4th Quarter, we are very encouraged by the strong market recovery that has extended from year-end into the New Year and continue to recommend investors maintain a long-term perspective and remain steadfast with investment programs. Corrections and even bear markets are common and part of the long-term investment process.

We are optimistic for 2019 but also urging caution as sharp downturns like in Q4 can often be followed by strong rebounds and further volatility as markets seek fair valuations amid new data like earnings, interest rates and economic growth prospects, as well as retest lows. Thus volatility remains in the forecast given the many moving variables.

Catalysts

A neutral Fed interest rate policy would lift uncertainty about US and global growth concerns

Corporate earnings growth is slowing from 20%+ levels but still expected to grow at mid-single-digits in 2019

US economy is slowing but still expected to grow at a healthy 2.0-2.5% clip in 2019, with a low chance of recession in next 12 months

Q4 Selloff created attractive values

Third year of a presidential cycle has been positive historically (but no guarantee)

Back to back negative years for stocks is rare (last time was 2000-2002)

Concerns

Tariffs and US-China trade war continues

Global growth continues to slow

Fed continues to raise interest rates despite softer data

Brexit is more uncertain than ever

Government shutdown drags on and takes a measurable toll on the US economy

New split Congress sparks gridlock

Russian investigation political fallout risk

It’s a New Year and now is a great time to review your portfolio, so be sure to call or e-mail your Nelson Advisor!

It's IRA Season and Contribution Limits for 2019 have increased to $6,000 from $5,500! Catch-Up Contributions remain at $1,000 for age 50+. 401(k) limits also increased to $19,000 from $18,500; Catch-Up Contributions remain at $6,000 for age 50+. You may need to adjust your monthly automatic investments to make sure you are on track to hit the new limits!

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